‘I believe in the integrity of Cdor’: Why Nova Scotia distanced itself from the Canadian benchmark rate

The world of fixed income often seems a placid, uneventful place, with all the excitement of a herd of cows. But every so often some apparently minor development occurs and everyone goes into a tizzy, making it appear the sky is about to fall.

That’s what happened last week when Nova Scotia treasurer Peter Urbanc told a reporter that his province had decided not to price an upcoming debt offering off Cdor, the Canadian version of Libor, and would instead move to the more obscure Canadian Overnight Repo Rate, or Corra, as a benchmark.

(Both rates are designed to reflect credit conditions and they’re widely used as benchmarks to calculate interest on bonds and a slew of other financial products as well. More about how they work in a moment.)

Mr. Urbanc told Bloomberg he favoured Corra because it’s set by the market as opposed to both Cdor and Libor, which are set by “a group of individuals.”

The comments highlight industry concern around the Libor fixing scandal, in connection with which at a group of international banks have paid fines of more than US$6-billion. Prosecutors allege that Barclays, Deutsche, JP Morgan and others manipulated the rate, which affects some US$350-trillion of securities, in order to profit.

The list of settlements and penalties is only going to get bigger as the international probe moves forward, and it’s already opened the floodgates for a slew of legal actions by shareholders and others. The final bill, once the dust has settled, will be around US$35-billion, according to a report by analysts at Keefe, Bruyette & Woods, a New York-based investment bank.

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It’s important to point out that no such claims have been made against Cdor, and Mr. Urbanc told the Financial Post he is confident there are no problems. “I believe in the integrity of the index,” he said. “Now, clearly there have been issues with Libor. It is different [from Cdor] but both these indices are based on a survey, so they’re not based on observable market data.”

Part of the reason for the switch, he said, is just that he likes Corra better because “it’s based literally on trades that take place, so it’s a market-based index, which I like.”

Other provinces are watching closely. Scott Blodgett, a spokesman for Ontario’s Ministry of Finance, said Canada’s most populous province “is evaluating the market and will assess the merits of such a product within our overall debt portfolio.”

However, Mr. Blodgett cautioned that “Cdor has not received the same criticism as Libor has and is therefore not a concern for us at this time.”

Officials at Quebec’s Ministry of Finance declined to comment.

As Mr. Urbanc explains, Corra is a market rate, based on repurchase transactions where financial institutions sell securities to other institutions, agreeing to buy them back the following day.

Cdor is the base rate at which banks lend to their corporate customers, and it’s calculated daily from submissions from a group of banks including the big domestic lenders. It’s not a market rate since actual transactions also include an additional fee based on the credit of individual borrowers.

Libor, by contrast, is the rate at which banks believe they can borrow from one another. But like the Canadian benchmark it’s hypothetical rather than market-based, since it’s not calculated from real-world transactions. Rather, it’s the product of a daily survey.

If Mr. Urbanc is choosing his words carefully, he has good reason. In recent years, Nova Scotia has issued billions of dollars of bonds priced off Cdor, including about $500-million in 2013 alone. When you include the other provinces and the federal government, the number gets a lot bigger. So it’s reasonable to assume that anyone who raises serious questions about the index might affect demand for the bonds, even hurt their value.

While it’s true that there have been no formal allegations regarding Cdor, an investigation by the Financial Post last year uncovered concerns among some market participants about transparency of the index and the lack of clear oversight or even management. Several players, who asked to remain anonymous, said they believe Cdor is subject to the same problems as Libor.

A little over a year ago the Investment Industry Regulatory Organization of Canada (IIROC) published the results of a review of the Canadian benchmark, which drew attention to a number of problems including — worryingly — lack of a common definition among the submitting banks of exactly what Cdor is.

According to the review — which was actually more of an opinion survey of IIROC members — even among the submitters said there is confusion about what exactly Cdor is. “Certain aspects of the definition are unclear. Most firms use similar inputs in calculating their submissions, but there is variation in a number of the assumptions made.”

In terms of who gets to be part of the survey, it appears a highly informal process without an administrator or even a clear set of credentials for potential submitters. In the words of IIROC: “Participation is currently voluntary and there are no documented criteria for participation.”

According to IIROC, survey participants believe it is helpful if potential participants are active issuers of bankers acceptances, since Cdor is supposed to be based on lending through a bankers acceptance facility. But they also acknowledge that if issuance becomes a requirement, there might not be enough banks in the group to produce a meaningful rate.

On the matter of supervision, IIROC goes to some lengths to lay out its argument that Cdor does not fall within its jurisdiction, at least not directly, since the individuals responsible for making the submissions are not generally employees of one of the investment dealers that IIROC oversees but rather of the parent bank which it does not oversee.

If that sounds like a regulator doing its best to dance around the subject, IIROC is not the only one. Recently the Office of the Superintendent of Financial Institutions (OSFI), which oversees banks, announced that it will “assume a role” in supervising “the effectiveness of the governance and risk controls surrounding banks’ CDOR submission processes.”

Many observers interpreted that as OSFI is taking over responsibility for the benchmark, but that is not quite the case. “We would like to clarify, OSFI is not the regulator of Cdor,” OSFI spokesperson Annik Faucher said in an email explaining the regulator’s limited supervision. “Other agencies have roles to play as well (e.g. IIROC).”

Such regulatory bickering might be ignored if there wasn’t so much at stake. Cdor is a hugely important piece of plumbing in Canada’s financial system, affecting the pricing of billions of dollars of government debt and also of a raft of other products, from corporate debt and interest rate swaps, to futures. All told, we’re talking about $6-trillion of financial products on any given day, according to Louis Gagnon, a professor at Queen’s School of Business.

With the evolution of the lithium-ion battery and pending availability of an affordable electric vehicle, we decided it was a good time to produce a Ubika Battery Metals Index, comprised of 10 lithium and 10 cobalt companies.

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